BUY: Legal & General (LGEN)
Legal & General delivered another half of rising dividends as interest rates boosted life insurers, writes Julian Hofmann.
Legal & General showed considerable resilience in its half-year results as rising interest rates started to make their impact felt in the annuity market and the company’s insurance reserves. The rising tide meant the life insurance provider saw surplus capital generation above its statutory solvency ratio, which in total was up by 14 per cent to £946mn, and meant it was able to continue the long unbroken rise in its already chunky dividend.
The shares didn’t really react on the day as the market seemed to take umbrage at the narrow miss in the group’s solvency ratio, which came in at 212 per cent, compared with the 215 per cent that management had pointed to in a prior trading update. It is fair to say that this sentiment may be overdone; the results clearly showed that Legal & General was able to organically generate excess capital across almost all its business lines.
The institutional business (LGRI), which is the biggest by net premiums written, saw profits rise by 7 per cent to £560mn. Rising interest rates affect the annuity market by prompting pension asset managers to transfer defined benefit liability risk to the life insurance industry. Rising rates mean the funding gap between income and liabilities has significantly narrowed since the Bank of England started raising interest rates, which allows an easier transfer of risk to LGRI, with the increased activity obvious in its half-year performance.
Legal & General’s other big divisions, LGC and LGIM, which specialises in alternative and general asset management, both saw more modest performance. LGC’s profits were up by 5 per cent to £263mn. By contrast, LGIM, being a general asset manager, was more exposed to market turbulence and profits here were essentially flat at £200mn.
Management reaffirmed its guidance for the long-term outlook on dividend and capital generation. LGEN expects to pay out between £5.6bn-£5.9bn in dividends by 2024 and to generate cash and capital of between £8bn-£9bn.
Legal & General’s results were positive and income investors will continue to appreciate the high-yielding dividend. The life sector is largely unaffected by inflation concerns, which have decimated the valuations for general insurers, by contrast. Broker Berenberg said the share valuation will depend on how quickly L&G can achieve its total target for operating profit of between £600mn and £700mn by 2025. Berenberg forecasts earnings per share for this year of 36.16p, giving a forward price/earnings ratio of 7.4.
SELL: Abrdn (ABDN)
Abrdn’s half-year results reveal that its name isn’t the only problem, writes Julian Hofmann.
Abrdn’s half-year results presented investors with all the woes and problems of being a large, listed asset manager, but notably few solutions as to how to turn around its chronic underperformance. Apart from wretched market conditions affecting its investment performance, Abrdn is flummoxed by the simplest of business problems — when revenues fall, so do profits. The complicating factor for a large asset manager is that revenues are linked to asset flows, and it is impossible to accurately predict how these might pan out.
Net outflows for the half were particularly noticeable in the institutional sector: net outflows here were £2.5bn higher than this time last year, as the market sell-off caused many of Abrdn’s clients to hold back from making investment decisions. Overall assets under management fell by 17 per cent to £386bn, with record redemptions as clients accessed uninvested capital, as well as selling equities. The market’s patchy performance also meant Abrdn took a hit to fee-based revenue, which was £546mn, compared with £613mn last time. Overall costs to income rose to 86 per cent as falling revenues sent the operational gearing on top of the company’s fixed cost base into reverse.
This was at the same time as the company is trying to integrate the Interactive Investor platform business acquired for £1.49bn at the end of last year. Management currently forecasts that it will book restructuring costs of £150mn this year, with the expectation that this will ultimately generate net savings by 2024 of £75mn. The performance of Interactive Investor has been the focus of a lot of interest. Management said after a month of full integration, ii saw a 17 per cent increase in revenue and 47 per cent increase in adjusted operating profit, based on a 2021 run rate.
Analysts at Panmure Gordon articulated many of the concerns over Abrdn’s earnings resilience as markets become more unpredictable. This is especially true as two-thirds of Abrdn’s market cap is tied up in listed entities beyond the operational control of management, according to the broker. Downgrades on the back of these results mean that the company’s shares are now rated at just under 21 times Panmure Gordon’s forecasts for earnings per share this year. Management seems to be pinning a lot of hope on Interactive Investor to turn around its underlying performance. Whether that ultimately justifies the price paid is open to debate.
HOLD: InterContinental Hotels Group (IHG)
A return of capital announcement is good news, but the outlook for travel and hotel demand is uncertain, writes Christopher Akers.
InterContinental Hotels Group revealed a $500mn (£413mn) share buyback programme and reinstated its interim dividend as the hospitality business — which owns Holiday Inn and Crowne Plaza — benefited from the removal of Covid-19 travel restrictions. But performance remains below pre-pandemic, and a challenging trading period lies ahead.
A rebound in business and group bookings helped IHG’s Americas market, its largest, put in a solid half against pre-pandemic comparisons. Revenue per available room (revpar), a key metric management uses to analyse hotel performance, was up by 3.5 per cent against 2019 and an operating profit of $351mn bettered the same year by over 2 per cent.
But at an overall level, revpar was down by 11 per cent against 2019 despite climbing by more than half against the pandemic-hit 2021. While sales in the Americas and Emeaa (Europe, Middle East, Asia and Africa) were up by 45 and 185 per cent respectively, trading in China was knocked by local travel restrictions and technology fee income struggled.
And thinking about the short to medium-term, it would be wise to be cautious when predicting the outlook for travel and hospitality. Inflation and cost pressures could hit leisure and corporate demand in the second half after some post-pandemic respite. Chief executive Keith Barr is, however, “confident in our business model and the attractive industry fundamentals that will drive long-term sustainable growth”.
Despite an uncertain outlook, investors will be cheered by the return of capital pay outs. The share buyback programme, which starts now and runs until January 31 at the latest, could feasibly be followed by the return of chunky special dividends. Net debt over adjusted cash profits was 2.1 times at June 30, below the target range of 2.5 to 3 times.
Peel Hunt analysts said that IHG “is well insulated from the direct impact of increased energy prices, but less immune to more general economic weakness filtering through to its hotel guests” and that these results “may represent a high-water mark in terms of hotel industry confidence for a while”. The shares trade at 17 times the broker’s forward 2023 earnings forecast, which looks attractive against the five-year average of 26 times according to FactSet data. Headwinds are incoming, but progress was made in the half.
Hermione Taylor: Will luxuries withstand a recession?
As inflation rises, evidence of consumer cutbacks is mounting. According to the Office for National Statistics, UK clothing stores saw demand fall by almost 5 per cent in June, and household goods stores fared little better.
Feedback from retailers suggests that consumers are reducing spending because of increased prices and affordability concerns.
Subdued spending is trickling down to company results too. Despite higher customer numbers, Ocado has seen lower spending from inflation-hit shoppers, and there are signs of consumers “trading down” to cheaper brands as they tighten their belts.
It would seem that customers are cutting back on discretionary purchases. But luxuries — the most discretionary of discretionary purchases — are performing well. The S&P Global Luxury Index rallied last month, despite lockdowns continuing to disrupt Chinese markets. There is evidence of buoyancy in the luxury services market, too. According to global hospitality and data analytics company STR, hotels in glitzy Dubai are seeing profitability levels seven times higher than in the same period in 2019.
Luxuries by their nature tend to demand high levels of inputs. This could be in the form of materials (think luxurious fabrics and precious metals) or labour (whether artisan craftsmanship or attentive service). This means that an environment of rising labour and energy costs puts significant upward pressure on luxury prices. According to STR, the average price of a London hotel room has now reached a record high of £209 a night, and luxury retailer Watches of Switzerland has reported rising prices across all brands.
Will consumers cut back as prices increase further? Market researcher Ipsos suggests that the answer could be complicated. Colin Ho, chief research officer, and Chris Murphy, president of market strategy and understanding, argue that consumers are open to switching within brands — a move known as cross-category indulgence. Rather than buying a product from a second-tier brand, squeezed consumers are often willing to stick with a premium brand — but choose a lower priced product instead. Ipsos cites the example of consumers swapping from a $2,350 bag to a “more affordable” $1,200 model from the same designer during the 2008 recession.
But inflation is not the only economic storm cloud on the horizon: luxury firms may soon find themselves contending with recession too. And in a time of increasing concern about the cost of living, might consumers show more distaste for conspicuous consumption?
This question has long been debated in economics. In 1982, Indiana University’s Zoher E Shipchandler posited that customers switch to goods with a perceived lower value in times of stagflation, in an attempt to “keep down with the Joneses”. The financial crisis later saw widespread predictions of a new era of “conservative consumption”. Could a similar move leave luxury brands vulnerable today?
Probably not. A 2010 paper from researchers at California’s UCLA and USC found no evidence of such restraint in reality. Joseph Nunes and colleagues found that designer handbags produced during the financial crisis actually displayed brand names far more prominently than the products withdrawn. The paper concluded that “conspicuous consumption endures in recessions”, and found that products introduced during recessions are “often louder, more expensive and featured in advertising” more than the products that came before.
Ipsos also highlights the appetite for luxuries during difficult economic times: Ho and Murphy argue that “the need for small indulgences to bring a little joy into an otherwise bleak time magnifies the role premium brands can play”. If their research holds true, luxuries could prove resilient: consumers might edge towards a brand’s “cheaper” luxury offerings, but are unlikely to give them up completely.
Hermione Taylor is an economics writer for Investors’ Chronicle